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‘Opportunity Zones’ can help investors, poor communities

WASHINGTON – Dec. 13, 2018 – One provision of the Tax Cuts and Jobs Act a year ago stands out for offering significant incentives to promote economic activity in particular places. The provision defers or reduces taxes on capital gains that are reinvested in certain preferred locations, called "Opportunity Zones" (OZs). The zones are census tracts selected by state governments, subject to certain restrictions, that are viewed as particularly worthy of additional capital inflows.

The stated rationale for this tax preference is that it will increase economic opportunity in disadvantaged areas. (A map and list of Florida Opportunity Zones is posted online.)

To be eligible for OZ designation, a census tract usually needs to have a poverty rate of at least 20 percent, or a median family income that is below 80 percent of the statewide median (or below 80 percent of the metropolitan area median if that is higher and the tract is inside a metro area). In addition, up to 5 percent of OZ tracts can be higher-income tracts that are contiguous to tracts that meet the poverty or income standards.

While the program may provide some benefits to lower-income Americans, it has at least four major drawbacks.

First, it is problematic to use the tax code to steer capital toward low-productivity uses. To the extent that Opportunity Zones are "correctly" identified, capital will be diverted from the highest-return investment opportunities to struggling areas hand-picked by policymakers. The worst-case scenario here is that OZ-fueled investment traps people in low-opportunity areas by temporarily raising labor demand while permanently expanding the housing stock.

Second, not all of the eligible tracts are comprehensively disadvantaged, not even those that are directly eligible under the income or poverty standards and certainly not those that are eligible because they are contiguous to low-income areas. Some tracts may contain a high-income population or significant economic activity alongside a large low-income population.

A good example that received significant recent media attention is Long Island City, much of which lies in OZ tracts, and which will soon be home to one of Amazon's new quasi-headquarters. A little south of there is the Brooklyn waterfront, another Opportunity Zone, eligible because its census tract is contiguous to a census tract that contains a sizable public-housing complex.

Third, even in tracts that are genuinely low-income, much of what may look like OZ-facilitated investment will simply displace existing investment. The most straightforward way to take advantage of the tax benefit is for a Qualified Opportunity Zone Fund to simply buy up existing properties located in Opportunity Zones. Such purchases will create the illusion of success by making the absolute investment numbers look good, even though they primarily benefit previous owners of the properties and investors in the fund rather than low-income residents.

Finally, the eligibility criteria are loose enough that cunning governors or mayors can simply select tracts that are already part of their preexisting economic development strategies and need no additional help from the government. All four of the locations Washington, DC, offered to Amazon for its HQ2, for example, are largely inside Opportunity Zones. The tax benefits in areas like this are likely to largely accrue to investors who would have invested even without the new tax break.

These caveats are important to keep in mind as we evaluate the effectiveness of this loophole as place-based policy and as anti-poverty policy. Its supporters have set high expectations, but previous initiatives along these lines have delivered mixed results at best.

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